Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Adient plc (NYSE:ADNT) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Adient's Net Debt?

As you can see below, Adient had US$2.54b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$890.0m in cash offsetting this, leading to net debt of about US$1.65b.

How Strong Is Adient's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Adient had liabilities of US$3.69b due within 12 months and liabilities of US$3.12b due beyond that. Offsetting these obligations, it had cash of US$890.0m as well as receivables valued at US$1.83b due within 12 months. So its liabilities total US$4.10b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the US$1.89b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Adient would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Adient has a quite reasonable net debt to EBITDA multiple of 2.3, its interest cover seems weak, at 2.4. This does have us wondering if the company pays high interest because it is considered risky. Either way there's no doubt the stock is using meaningful leverage. The bad news is that Adient saw its EBIT decline by 15% over the last year. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Adient can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Adient's free cash flow amounted to 42% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We'd go so far as to say Adient's level of total liabilities was disappointing. Having said that, its ability to convert EBIT to free cash flow isn't such a worry. After considering the datapoints discussed, we think Adient has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Adient (1 makes us a bit uncomfortable) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.